Over the past two years, the US has faced a series of challenges that have tested its resilience. Alongside the global battle against the pandemic, the nation has grappled with a surge in inflation, adding to its woes. The inflationary surge has prompted the US Federal Reserve (the Fed) to raise its base interest rates by 500-basis points cumulatively in slightly over a year.
Yet, amid challenging circumstances, the US has experienced a significant improvement in its economic prospects, as highlighted by Cebr’s latest projections. Initial estimates, which indicated a mere 0.3% growth at the beginning of this year, have been revised upwards to a more robust 1.3%, considering stronger-than-expected Q1 data. The resolution of the debt ceiling issue, which had posed challenges for policymakers, has restored confidence in the federal government’s ability to fund projects. The housing market has seemingly stabilised, with housing starts in May reaching their highest level since April 2022. Despite earlier concerns, the banking crisis has had a relatively modest impact thus far, acting as a minor drag. Furthermore, the possibility of stricter credit controls offers an alternative to further interest rate hikes, thereby mitigating the projected peak of interest rates. These favourable developments have significantly reduced the potential for a US recession.
Additionally, the nation has experienced a significant decline in inflation, plummeting from its peak of 9.1% to 4.0% in May. This drop lends credibility to the Fed’s assertive tightening measures, projected to conclude within this year. The nation’s relative resilience against energy shocks does help, having been a net exporter of energy and producing more than it consumes. While this resilience does not shield the country entirely from energy price shocks, as demonstrated in the past year, it does help keep the inflationary impacts of energy price shocks in the US transient, thereby reducing the impact on consumers.[1] The US also possesses a distinct competitive edge over Europe when it comes to consumer energy costs. Unlike their European counterparts, American consumers are not burdened with directly shouldering the expenses associated with the transition to renewable energy sources.[2] The recently enacted Inflation Reduction Act is expected to further reduce energy costs by $500 per year for the average household, exacerbating this divide further.[3]
Nonetheless, pessimism continues to surround the US economy. For example, in May, Gallup’s Economic Confidence Index reached its lowest level since the conclusion of the Great Recession in early 2009.[4] This contrasts with the general improvement in confidence in the UK and the Eurozone over the last six months, as evidenced by the YouGov/Cebr Consumer Confidence Index and the European Commission’s consumer confidence measure, respectively, even as the economic outlook across Europe remains highly challenging.
It might be a case of US consumers being more realistic in their assessment of growth prospects in an environment characterised by high inflation and the Fed’s relentless campaign of raising interest rates. These concerns become particularly pertinent when considering the projected economic performance for the US in H2 2023. Our projections suggest that the US is expected to experience two consecutive quarters of contraction in Q3 and Q4 despite the overall upward revision to our forecast.
However, it is important to recognise that such a mild slowdown, although concerning, should not be regarded as the definitive indicator of economic stability. Similar to last year, the National Bureau of Economic Research might well refrain from formally designating the shallow contraction as a full-blown recession. This is due to the relatively strong macroeconomic fundamentals that have helped the US economy outgrow its peers in the post-pandemic period.
Figure 1: Quarterly GDP growth by market economy
Source: Macrobond
One potential explanation for prevailing pessimism is the detachment of sentiment from macroeconomic fundamentals in the US. Traditionally, individuals’ sentiment would be influenced by economic conditions; however, during the post-Covid period, there seems to have been a decoupling between the two factors in the US. Despite the normalisation of output growth and the labour market in the post-pandemic period, real wages have significantly declined, which has coincided with a decrease in sentiment. It is plausible that the inability of wages to keep pace with inflation, a prominent feature of the post-Covid period, has resulted in sentiment becoming closely tied to real wages, and real wage contractions have in turn ushered in a highly pessimistic consumer base.[5]
This detachment could be attributed to the impact of the Tax Cuts and Jobs Act of 2017, which saw a period of reduced taxes, substantial wage growth and robust GDP growth. Despite concerns over its regressive nature, the Act led to a notable decrease of 13% in average effective tax rate, with every income group benefitting on average.[6][7] Furthermore, the decrease in business tax rates stimulated economic activity, resulting in unprecedented wage growth, surpassing pre-Great Recession levels. This period also witnessed a surge in economic confidence on the Gallup index, reaching its highest level since the late 90s. Consequently, it is plausible that during this period, American consumers shifted the basis of their sentiment from economic conditions to the significant progress in wage growth.
In all, the US’ stronger fundamentals have enabled it to gain a stable foundation in a global economy facing multiple headwinds, allowing it to confound expectations of a looming recession. Yes, an environment of elevated interest rates has and will slow growth, but empirical evidence suggests that the US is better placed to cope with this without it translating into a wider downturn, compared to its peers. As such, it is likely that underlying pessimism is likely more of a function of real wage contractions rather than a reflection of economic conditions. In turn, an expected decline in inflation will inevitably pave the way for real wage growth, alleviating some of the prevailing pessimism in the economy and restoring alignment between sentiment and economic conditions.
[1] Centre for Economic Policy Research (CEPR)
[5] Grant (2022) – The Great Decoupling: Macroeconomic Perceptions and COVID-19
For more information, please contact:
Pushpin Singh, Economist
Email: psingh@cebr.com, Phone: 020 7324 2871
Cebr is an independent London-based economic consultancy specialising in economic impact assessment, macroeconomic forecasting and thought leadership. For more information on this report, or if you are interested in commissioning research with Cebr, please contact us using our enquiries page.